Stocks: Calm before the storm?

After a productive summer that saw the averages gain their sea legs following the April/May correction, the Nasdaq Composite
COMP, -0.08%
is perched at levels not seen since late '00.

This is when the fun begins.

There is the best three-month period of the year — November, December, January — looming in the distance. But closer in, there is the often-treacherous September/October period to navigate.

There is the possibility that this year there is no correction in September/October. This is deemed unlikely. If it was to happen, it would represent the unexpected. And it is the unexpected that is always worth paying attention to. Unexpected strength in the face of Europe's quagmire, China's ongoing slowdown, the fiscal cliff, and the wild card of a potential Israel-Iran altercation, would speak loudly.

The cup patterns currently seen in the major averages usually show some sort of pullback near the top of the cup's right side. The above chart shows a sideways drift, a handle of sorts to go with the cup.

The chart of the Dow Jones Industrials
DJIA, -0.35%
below shows the handle to be sloping down.

A comparison of the two handles — the more growth-oriented, speculative average (Nasdaq) moving sideways while that of the blue-chip average pulls back — is a bullish omen. It says something about the speculative sentiment, a necessary requirement of any durable bull market.

Given the 13.7% move from the Nasdaq's June 4 low to its 3,100 high of two weeks ago, and in light of the crosscurrents that often plague the market in September/October, it is logical to expect a correction.

Should this transpire, it will be important to watch how leading stocks act, especially on up days during the pullback.

The above discussion notwithstanding, a speculator using the strategy expounded upon in these missives will not concern herself with attempting to predict where the market will go. She will act upon an understanding of the price/volume behavior of the major averages and the action of the leading stocks.

And nothing else.

Among the names, Servicenow
NOW, +0.87%
a provider of cloud-based IT software, came public June 29 at 18 before running up to 33.96 in about six weeks, an 89% move. Most analysts expect NOW to clock a 24-cent-a-share loss in '12, followed by a per-share profit of a penny in '13.

With younger companies that are not showing a profit currently, it can be useful to look at sequential revenue growth over the past few quarters (quarter to quarter, not quarter to year-ago quarter). Seeing sequential rates of at least 10% is impressive. In NOW's case, this amounts to growth rates of 15%, 21%, and 20%, over the past three periods, respectively. That NOW is able to grow revenue at a significantly faster rate than 10% says something.

And because the time frame of this strategy is intermediate- (several weeks to several months) and not long-term, the sequential revenue metric is all that is needed to provide some evidence that fundamental momentum at the company is vibrant.

Technically, any stock in a growth industry that moves up 40%-50%+ shortly after its initial public offering is worthy of this column's attention. NOW has obviously done this. The chart below shows a three-week shelf pattern, as price works off some of the froth related to its summer surge.

In a perfect world, price would pause to form a five-week-or-longer base. This would allow for an attractive entry. Newly-minted glamours like NOW do not often accommodate the speculator's wishes. For now, this is well worth watching to see how it acts around its high of 33.96.

Express Scripts Holding
ESRX, -0.42%
was noted here on Aug. 9 ("...[ESRX] blasted out of a beautiful cup-with-handle base...earnings stability, at an annualized standard deviation of just 3% over the past several years, is practically as high as it gets in the entire market. Stocks with this level of earnings growth and this stability of growth do not grow on trees.").

Earnings growth estimates, according to most analysts, have been recently bumped up to 25%/22% for '12/'13. The provider of pharmacy benefit management services is seeing the relative strength in its industry group (medical services) in the top decile of all groups.

Technically, ESRX backed and filled for three weeks following the above-noted breakout, which came out of a 15-month pattern. For a more-conservative speculator in growth stocks, ESRX offers a potential entry at current levels, using a junior-sized position and a stop below the 50-day moving average in the 58 area. This works out to risk of about 7%, and 3.5% if a half-sized position is used for entry.

In summation, volatility can be expected to pick up significantly from August levels. The averages and individual leaders show good tone. Some, but not many, growth stocks set up in attractive chart patterns, and these have been discussed over the past several reports. Seasonal softness is to be expected.

At the time of this writing, of the stocks mentioned in this report, Kevin Marder or an affiliate thereof held no positions, though positions are subject to change at any time and without notice. The information contained herein may have been previously disseminated.

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